Chapter 1.ppt fin statement valuation and anakysis

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1. COPYRIGHT ©2011 South-Western, a part of Cengage Learning.
Introduction to
Financial Reporting
Chapter 1

2. Copyright 2011 by South-Western, a part of Cengage Learning. All rights reserved. Chapter 1, Slide #2
GAAP
•Generally Accepted Accounting Principles
(GAAP) in United States
•Major Sources of GAAP
–Securities and Exchange Commission (SEC)
–American Institute of Certified Public Accountants
(AICPA)
–Financial Accounting Standards Board (FASB)

3. Copyright 2011 by South-Western, a part of Cengage Learning. All rights reserved. Chapter 1, Slide #3
FASB Structure
Exhibit 1-1

4. Copyright 2011 by South-Western, a part of Cengage Learning. All rights reserved. Chapter 1, Slide #4
FASB Conceptual Framework
•A system of interrelated objectives and
underlying concepts
•Serves as the basis for evaluating existing
standards of financial accounting and reporting
•(SFASs).
•SFACs
–Statements of Financial Accounting Concepts

5. The Need for a Conceptual Framework
To develop a coherent set of standards and rules.
To solve new and emerging practical problems
Copyright 2011 by South-Western, a part of Cengage Learning. All rights reserved. Chapter 1, Slide #5

6. The FASBhas issued seven Statements of Financial
Accounting Concepts(SFAC) for business enterprises.
Development of Conceptual Framework
SFAC No.1-Objectives of Financial Reporting.
SFAC No.2-Qualitative Characteristics of Accounting Information.
SFAC No.3-Elements of Financial Statements.
SFAC No.4-Recognition and Measurement in Financial Statements.
SFAC No.5-Elements of Financial Statements (replaces SFAC No. 3).
SFAC No.6-Using Cash Flow Information and Present Value in
Accounting Measurements.
SFAC No.7-The Objective of General Purpose Financial Reporting and
Qualitative Characteristics of Useful Financial Information
(replaces SFAC No. 1 and No. 2)
LO 2

7. First Level= Basic Objectives
Second Level= Qualitative
Characteristics and Elements
Third Level= Recognition,
Measurement, and Disclosure
Concepts.
Conceptual Framework
LO 2 Describe the FASB’s efforts to construct a conceptual framework.
Overview of the Conceptual Framework

8. First Level: Basic Objectives
LO 3 Understand the objectives of financial reporting.
Objectiveof general-purpose financial reporting is:
To provide financial information about the reporting entity
that is useful to present and potential equity investors,
lenders, and other creditors in making decisions
about providing resources to the entity.

9. “The FASBidentified the Qualitative Characteristicsof
accounting information that distinguish better (more useful)
information from inferior (less useful) information for
decision-making purposes.”
Second Level: Fundamental Concepts
LO 4 Identify the qualitative characteristics of accounting information.
Qualitative Characteristics

10. Second Level: Qualitative Characteristics
LO 4 Identify the qualitative characteristics of accounting information.
Illustration 2-2
Hierarchy of
Accounting Qualities

11. Second Level: Qualitative Characteristics
Fundamental Quality—Relevance
To be relevant, accounting information must be capable of
making a difference in a decision.
LO 4 Identify the qualitative characteristics of accounting information.

12. Second Level: Qualitative Characteristics
Fundamental Quality—Relevance
Financial information has predictive valueif it has value as an
input to predictive processes used by investors to form their own
expectations about the future.
LO 4 Identify the qualitative characteristics of accounting information.

13. Second Level: Qualitative Characteristics
Fundamental Quality—Relevance
Relevant information also helps users confirmor correct prior
expectations.
LO 4 Identify the qualitative characteristics of accounting information.

14. Second Level: Qualitative Characteristics
Fundamental Quality—Relevance
Information is material if omitting it or misstating it could
influence decisions that users make on the basis of the reported
financial information.
LO 4 Identify the qualitative characteristics of accounting information.

15. Second Level: Qualitative Characteristics
Fundamental Quality—Faithful Representation
Faithful representationmeans that the numbers and
descriptions match what really existed or happened.
LO 4 Identify the qualitative characteristics of accounting information.

16. Second Level: Qualitative Characteristics
Fundamental Quality—Faithful Representation
Completenessmeans that all the information that is necessary
for faithful representation is provided.
LO 4 Identify the qualitative characteristics of accounting information.

17. Second Level: Qualitative Characteristics
Fundamental Quality—Faithful Representation
Neutrality means that a company cannot select information to
favor one set of interested parties over another.
LO 4 Identify the qualitative characteristics of accounting information.

18. Second Level: Qualitative Characteristics
Fundamental Quality—Faithful Representation
An information item that is free from errorwill be a more
accurate (faithful) representation of a financial item.
LO 4 Identify the qualitative characteristics of accounting information.

19. Second Level: Qualitative Characteristics
Enhancing Qualities
LO 4 Identify the qualitative characteristics of accounting information.
Information that is measured and reported in a similar manner
for different companies is considered comparable.

20. Second Level: Qualitative Characteristics
Enhancing Qualities
LO 4 Identify the qualitative characteristics of accounting information.
Verifiabilityoccurs when independent measurers, using the
same methods, obtain similar results.

21. Second Level: Qualitative Characteristics
Enhancing Qualities
LO 4 Identify the qualitative characteristics of accounting information.
Timelinessmeans having information available to decision-
makers before it loses its capacity to influence decisions.

22. Second Level: Qualitative Characteristics
Enhancing Qualities
LO 4 Identify the qualitative characteristics of accounting information.
Understandabilityis the quality of information that lets
reasonably informed users see its significance.

23. Copyright 2011 by South-Western, a part of Cengage Learning. All rights reserved. Chapter 1, Slide #23
Elements of Financial Statements
(SFAC 6)
•Assets
–• a resource
–• controlled by the entity
–• as a result of past events
–• from which future economic benefits are expected to
flow to the entity.
–Liabilities
–a present obligation (not a future commitment!)
–• of the entity
–• as a result of past events
–• the settlement of which is expected to result in an
outflow from the entity of economic benefits.

24. Copyright 2011 by South-Western, a part of Cengage Learning. All rights reserved. Chapter 1, Slide #24
Elements of Financial Statements
(SFAC 6) (con’t)
•Equity
–The owner’s residual interest in the assets after
deducting liabilities
•Revenues
–Inflows and other enhancements of revenue or reductions of
liabilities from delivering or providing goods or services
related to the central operations
•Expenses
–Outflows or consumption of assets from delivering or
providing goods or services related to the central operations

25. Copyright 2011 by South-Western, a part of Cengage Learning. All rights reserved. Chapter 1, Slide #25
Recognition and Measurement (SFAC 5)
•To be recognized an item should be
–One of the defined elements
–Measurable with sufficient reliability
–Based on information that is
•Relevant
•Reliable
•Measurement attributes
–Historical cost/proceeds
–Current cost
–Current market value
–Net realizable (settlement) value
–Present (discounted) value of future cash flows

26. Copyright 2011 by South-Western, a part of Cengage Learning. All rights reserved. Chapter 1, Slide #26
Traditional Assumptions
of the Accounting Model
•Business Entity
•Going Concern (Continuity)
•Time Period
•Monetary Unit
•Historical Cost
•Conservatism
•Realization
•Matching
•Consistency
•Full Disclosure
•Materiality
•Industry Practices
•Transaction Approach
•Cash Basis
•Accrual Basis

27. Copyright 2011 by South-Western, a part of Cengage Learning. All rights reserved. Chapter 1, Slide #27
Business Entity
•The business entity is separate and distinct
from the owners of the entity
•The entity is an economic unit that stands on
its own

28. Copyright 2011 by South-Western, a part of Cengage Learning. All rights reserved. Chapter 1, Slide #28
Going Concern (Continuity)
•The entity will remain in business for an
indefinite period of time
•Disregards possibility of liquidation or
bankruptcy
•Impacts how assets and liabilities are
measured and reported
•Financial statements must disclose if the
presumption of continuity is not applicable

29. Copyright 2011 by South-Western, a part of Cengage Learning. All rights reserved. Chapter 1, Slide #29
Time Period
•Finite reporting periods applied to the
presumed indefinite life of a business
–Natural business year
–Calendar year
–Fiscal year
–52-53 Week fiscal year
•Allows measurement of the results of
operations prior to the liquidation of a business
entity’s life

30. Copyright 2011 by South-Western, a part of Cengage Learning. All rights reserved. Chapter 1, Slide #30
Monetary Unit
•Standard of measure for business transactions
•U.S. dollar for domestic entities
•Supplementary disclosure of inflation-adjusted
financial data currently not required by U.S.
GAAP

31. Copyright 2011 by South-Western, a part of Cengage Learning. All rights reserved. Chapter 1, Slide #31
Historical Cost
•Often used because it is objective and
determinable
•Acceptable deviations
–When it becomes apparent that the historical cost
cannot be recovered (justified by the conservatism
concept)
–Where specific standards call for another
measurement attribute such as current market
value, net realizable value, or present value

32. Copyright 2011 by South-Western, a part of Cengage Learning. All rights reserved. Chapter 1, Slide #32
Conservatism
•Select from various measures of value
•Each of the alternatives must have reasonable
support
•Conservatism guides selection of the
alternative that has the
–Least favorable impact on net income
–Least favorable impact on financial position

33. Copyright 2011 by South-Western, a part of Cengage Learning. All rights reserved. Chapter 1, Slide #33
Realization of Revenue
•In general, the point of recognition of revenue
should be the point in time when revenue can
be reasonably and objectively determined
•Point of sale
–Earning process is virtually complete
•End of production
–If price of item is known and a ready market exists
•Receipt of cash
–Collection cannot be reasonably estimated

34. Copyright 2011 by South-Western, a part of Cengage Learning. All rights reserved. Chapter 1, Slide #34
Realization of Revenue (cont’d)
•During production
–Revenue is recognized proportional to effort
•Cost recovery
–Applicable for highly speculative transactions
•There are many other acceptable methods of
recognizing revenue

35. Copyright 2011 by South-Western, a part of Cengage Learning. All rights reserved. Chapter 1, Slide #35
Matching
•Match costs associated with revenue
recognized
–Direct association (i.e., inventory sales and cost of
the inventory)
•Costs that have no direct connection with
revenue
–Systematic recognition, usually in the period
incurred

36. Copyright 2011 by South-Western, a part of Cengage Learning. All rights reserved. Chapter 1, Slide #36
Consistency
•Same accounting treatment given to
comparable transactions from period to period
•Entity results from several years are
comparable
•Supports trend analysis
•If a change is made
–Justification of change is discussed
–Impact of the change on the financial must be
explained

37. Copyright 2011 by South-Western, a part of Cengage Learning. All rights reserved. Chapter 1, Slide #37
Full Disclosure
•Accounting reports must disclose all the facts
that may influence the judgment of an
informed reader
•Methods of disclosure
–Parenthetical
–Supporting schedules
–Cross-references
–Footnotes
•Reasonable summary of significant financial
information

38. Copyright 2011 by South-Western, a part of Cengage Learning. All rights reserved. Chapter 1, Slide #38
Materiality
•Considers the relative size and importance of
an item to the business entity
•Immaterial items not subject to concepts and
principles
–Handle in most economical and expedient manner
•Does the information influence an informed
reader of the financial statements?
–Yes: material
–No: immaterial

39. Copyright 2011 by South-Western, a part of Cengage Learning. All rights reserved. Chapter 1, Slide #39
Industry Practices
•Industry-specific reports
•Do not conform to general accounting
guidelines
–Government regulation
–Unique needs or peculiarities of an industry
•Effort to minimize but will probably never be
completely eliminated

40. Copyright 2011 by South-Western, a part of Cengage Learning. All rights reserved. Chapter 1, Slide #40
Transaction Approach
•Record transactions that
–Affect the financial position of the entity
–Can be reasonably determined in monetary terms
•Many transactions are nonmonetary in nature
–Not recorded
–May be disclosed in compliance with “full
disclosure” principle

41. Copyright 2011 by South-Western, a part of Cengage Learning. All rights reserved. Chapter 1, Slide #41
Cash Basis
•Recognize revenue when cash is collected
•Recognize expense when cash is paid
•Usually does not provide reasonable
information about the earning capability of the
entity in the short run
•Acceptability
–Usually not GAAP
–May be used if difference between cash basis and
accrual basis is not material

42. Copyright 2011 by South-Western, a part of Cengage Learning. All rights reserved. Chapter 1, Slide #42
Accrual Basis
•Revenue recognized when realized
(realization concept)
•Expenses recognized when incurred
(matching concept)
•Numerous year-end adjustments required
•More complex than cash basis

43. Copyright 2011 by South-Western, a part of Cengage Learning. All rights reserved. Chapter 1, Slide #43
Accrual Basis (cont’d)
•Result is more representational of financial
condition
•Supports the time periodassumption
•Modified accrual
–Adjusts for buildings and equipment
–Immaterial items
–Specific standards have allowed the cash basis

44. Any Questions?
Copyright 2011 by South-Western, a part of Cengage Learning. All rights reserved. Chapter 1, Slide #44

45. Thanks
Copyright 2011 by South-Western, a part of Cengage Learning. All rights reserved. Chapter 1, Slide #45